ON THE RECORD: Riverside seeks gems in haystack

John Kuntz / The Plain DealerRiverside Co. co-CEO Stewart Kohl stands next to a photograph titled "Powerhouse Mechanic," part of a collection of work portraits taken by photographer Lewis Wickes Hine in the 1920s and 1930s. The photo is one of many vintage portraits and artwork lining the walls of Riverside's Terminal Tower offices in Cleveland. • Video: Watch the interview

Stewart Kohl likes to mix metaphors when he describes the mission of Riverside Co., one of Cleveland's biggest and most active buyout firms.

"Our model has been alternately described as looking for the jewel in the rough, or the needle in the haystack," Kohl says. "Perhaps it's a combination. We're looking for the jewel in the haystack."

If the last several years are any indication, Kohl and his staff of 160 aren't having much trouble finding gems.

Riverside's buying pace last year was dizzying -- snapping up 28 businesses, or one every 12 days, in a year in which private equity spending tailed off considerably at the upper end of the deal-making spectrum. In 2008, the company already has made nine purchases.

Its secret is its niche. Riverside buys companies at the smaller end of the middle market -- ones it can acquire for $150 million or less -- and then tries to double or triple them.

Watch video highlights of the interview with Stewart Kohl and see our archive of 16 other CEO interviews at cleveland.com/ontherecord.

Kohl, 52, is Riverside's co-CEO, sharing the title with Bela Szigethy, who runs the firm's New York office. It was Szigethy who founded the company in 1988 in his Manhattan apartment overlooking the Hudson River.

They've been acquaintances since their undergraduate days at Oberlin College in the 1970s but didn't decide to join forces until 1993, when Kohl left CitiCorp Venture Capital in Cleveland. Neither wanted to move so they opted for co-headquarters, talking by phone every day and looking for deals in their geographic areas.

"We still talk every day," Kohl says. "We still source from our offices, but now it's 17 of them around the world."

Kohl sat down recently with Plain Dealer reporters and editors to discuss everything from his Golden Rule for working at Riverside to a $5 million gift he and his wife, Donna, gave to construct a new home for Oberlin's jazz studies program. This interview has been edited for space and clarity.

Q: Why is it that your business doesn't seem to be affected yet by what's happening in the economy?

A: I'm glad you said "yet" because, as we speak, the effects are being felt. There has been a wrenching credit contraction. If we were doing large buyouts where we needed to raise large sums of debt in syndicated transactions, our business would be shut down.

The advantage we have in this environment is that we're dedicated to the small end of the middle market. We can work with a handful of banks with whom we've worked for up to 15 years.

We've bought about 180 companies. About 100 were new platforms where we raised new debt. We've only lost money in five of those, which is a very low percentage. Banks view us as a good credit risk. In addition, we have a large pool of capital, about $1.8 billion, to do deals.

In a period like this, we're focused on the quality of the company we're acquiring. If we're buying a great little company for its fair market value, and if we have ideas for how to double or triple that company over the next three to seven years, we'll be delighted to buy, almost regardless of the capital markets.

Q: How do you go about doubling or tripling a company?

A: One reason I still love what I do is because there is no cookie cutter. Every deal is unique.

GreenLine Foods Inc. in Bowling Green, Ohio, is an example of just one way it works. Founder and owner Jeff Twyman wanted to take some chips off the table so he could diversify his personal wealth, which is a pragmatic and correct thing to do. If you met Jeff, you would see he's not the retiring type. He's on a mission to spread green beans throughout North America, and maybe someday, around the world.

Already together, we've made an add-on acquisition. We have other acquisitions in our pipeline, which would give him the ability to add geography to cover the whole continent and the opportunity to offer other vegetables, using the same logistics and distribution.

Q: Are you simply looking for complementary businesses that enable portfolio companies to increase market share?

A: That's an important part of what we do. It's typical for us to do one, two or three add-ons during the life of a Riverside investment. The companies we're investing in are not growing 50 percent or 100 percent a year. They're not high-risk technology businesses.

The businesses we're acquiring are growing somewhere between 5 percent and 25 percent a year. When add-ons are done right, you can find ways to make one plus one equal three.

Stewart A. Kohl

Age: 52

Birthplace: Leonia, N.J.

Residence: Shaker Heights

Family: He and his wife, Donna, have a daughter and three grandchildren.

Education: Bachelor's degree from Oberlin College.

Career path:

Became co-chief executive officer of Riverside Co. in 1993

Before that, he was vice president of Citicorp Venture Capital Ltd. in Cleveland

Community involvement:

Serves on the board of directors of Oberlin College, the Museum of Contemporary Art in Cleveland, and the Rock and Roll Hall of Fame and Museum

Serves on the council of advisers of ShorBank

For nine years, he has been a "heavy hitter" participant in the Pan Mass Challenge bicycle fund raiser for Dana-Farber Cancer Institute.

Q:How long have you been invested in GreenLine?

A: We made the original investment in 2006. Riverside investments typically have a life of three to 10 years. Three would be quite short, and 10 would be quite long. More normally, five to seven years.

The industry as a whole would be a little shorter and for good reason. They start with larger companies. They have less work to do to build them up. We invest heavily up front to position a company to make it bigger and better.

A recession, a downturn, will add two years to the hold period across private equity. That doesn't trouble us. It's a phenomenon we saw in 2001 and 1991.

Q:Who are your investors and are they patient to wait through longer hold periods?

We have investors like Traveler's or Liberty Mutual or Northwestern Mutual Life. Locally, National City and KeyCorp would be investors. Stanford University and the Getty Trust also would be investors.

To some degree, we attract high net worth individuals who operate more like a small institution in the way they allocate their assets and invest. It's professionally managed. It's not the individual doing his or her own investing. These folks have made a decision to allocate a portion of their assets to private equity. They understand it's a class which has the promise of higher rewards. That's what they're striving to achieve.

Q: What is your average rate of return to investors?

A: If you measured the returns on companies we bought and sold, that would translate into about a 55 percent compounded annual return. But it's not the only, or best, way to evaluate our performance, even though it's quite factual.

The reason is because we own many more companies we haven't sold. You could worry that we sell the winners and hide the losers. Sophisticated investors will say, "Let's look at the value of all of your deals. We don't have a fact for what they're worth today, but we can do some valuations." When they do that math, they conclude our returns are about 35 percent. That's an excellent return.

Our investors are comfortable with our unique business model -- our dedication to the small and middle market. With all the resources we bring to that, we can continue to generate returns to them that will be no worse than the high teens and could be as good as the low 20s. That's more than they're going to get from the public equity market.

Q: Has your investor pool changed over the years?

A: It has completely changed. We didn't have a fund of our own until 1995. Before 1995, we would find a company fitting our criteria, put up our own money, which was relatively pennies, and find an institutional equity partner to put up the bulk of the money. In those days, Society Venture Capital, which then became Key Equity Capital, was our partner.

In 1995, we said to ourselves, "We've done some deals. They've worked. Wouldn't it be great if we could have our fund?" We went out and raised $34 million. We invested in six companies over the ensuing three years.

Come 1998, we were ready to raise our next fund. This time we raised $107 million from that same group of investors. We invested in 11 companies over the next 2 years. At that point, we said, "We're really ramping up. We're finding a lot of great little companies."

Our existing investor base, which I'll define as our friends and family -- not literally, but people who knew us and liked us, was not going to be big enough for what we needed to do.

We did 200 presentations in a year. We targeted to raise $250 million, but ended up with $413 million. We had finally established our real investor base.

Q: Were you selling the same niche that you target today?

A: It hasn't changed in 20 years, which is amazing. What has changed is the world's view of the niche.

When we went out to raise money in 1999, venture capital was all the rage and people were interested in where they could make 10 or 100 times their money, not two or three times. We were the guys in the corner at the cocktail party who talked with the serving staff because nobody else wanted to talk to you.

As we went on in our fund raising, the markets cratered and venture capital was significantly affected. A few smart investors said to themselves, "Where are the other niches in private equity?" They concluded this small end was a niche. By the end, folks wanted to talk to us at that cocktail party.

Q: Didn't your success bring more competition?

A: We have a lot of competition. There are 1,500 private equity firms in North America alone. Many of them do small deals. The difference is we are the only one that does the number of small deals we do on a global basis, bringing all of the resources that we bring -- 160 people, $1.8 billion in assets, 17 offices, a team of 20 operators who can help businesses succeed.

Our more institutional approach resonates with a group of investors. What's interesting is that same story that resonates with investors also resonates with a group of owners, sellers and managers who want more from their private equity investor than just green dollars.

On The Record is a series of in-depth interviews with top Northeast Ohio business leaders.

Q: Riverside's deal count has been going up annually -- 28 last year, 26 the year before and 17 in 2005. What kind of pressure is there to up that count every year?

A: There is no pressure from our investors. Our investors are focused on our returns and the quality of the investing, not quantity.

All of us at Riverside are investors in our own funds. Five percent of all of the money Riverside raises comes from Riverside employees so we're also concerned about quality and returns.

At the size range we're interested in, there are millions of businesses. Even if you're choosy, there's still hundreds of thousands to consider investing in, and tens of thousands you covet. If there is pressure to do more, it's because we see a lot of opportunity.

In 2007, our deal sourcing team found 3,500 opportunities for us to consider. Of those, we visited 400. That's about eight a week. It's a very active program of kicking the tires. Of those, we bought 28. That gives you a good sense of the numbers.

Q: Why do business owners decide to sell to private equity?

A: Sellers decide they're sellers for many different reasons. It could be a death. We've bought from estates. We've bought from owners with fatal cancer diagnoses. It could be a divorce. It could be retirement or lifestyle changes or estate planning.

Often, sellers are not classic sellers. They're like Jeff Twyman at GreenLine or perhaps even closer to home, like Tim McCarthy at WorkPlace Media in Mentor. They want to see their business grow and succeed, and they still want to be a part of it. In those situations, called recapitalizations, we'll buy a majority interest and we'll work together to double or triple the size of that business by bringing our capital and our know-how.

What they're focused on is the fun they can now have with more resources behind them. When it works, the second bite of the apple -- the first bite came when we bought 60 percent to 80 percent -- when the rest is sold can be bigger and sweeter than the first.

Q: What has been your single best investment?

A: In Europe, we had the opportunity to invest in a recapitalization of Welltec, a very interesting company that had come up with a better mousetrap in a classic sense. It's a tractor that could crawl down into a well, oil or natural gas, and clean it out, perform a variety of functions, and keep the well operating at high productivity.

It was already a successful, profitable business. We did an add-on in Calgary to give access to the rapidly growing Canadian and Alaskan market. The company grew splendidly.

We invested $17.6 million. Our gross cash-on-cash was just about 10 times. That means we turned $17.6 million into almost $176 million.

Q: Looking back, should you have kept that investment longer?

A: Most of the companies we've sold have done well or very well for the next owner. We do track it, and we never look back. We never second-guess.

If we delivered a large return to our investors, that's what they paid us to do and we did it. The world is risky and unknowable, and our investors don't want us holding things forever.

We think our reputation is enhanced by selling excellent companies. When a buyer buys a Riverside company, it's not a pig in a poke. All we ask is that they show the love in their purchase price.

Q: In pursuing your international strategy, how do you size up small companies in new markets overseas?

A: We are never a foreign buyer. We are always a local buyer because we're always operating locally.

If you were to visit Riverside in Tokyo, you'd meet with Japanese. If you visit us in Munich, you'd meet with Germans. We pay attention to local culture and norms, but we bring to it a process and a set of resources that's global. It's our variation on think local, act global.

It does make managing the firm harder, but we don't feel we're taking on extra risk because we're doing it locally. If I were sitting in Cleveland and acquiring Shinsouki, a parking lot operator in Niigata City, Japan, as we did in January, I would be scared. I'm not doing it. The team in Tokyo is doing it.

When you think about Asia, it's easy to say you should go to China and India because they're big and they're growing fast. The problem is we're cowards. Those markets scared us. Despite what we do for a living, we're pretty conservative. We want to study them and watch them, but we're not ready to be investors in those markets.

We researched Japan, South Korea, Singapore and Australia. Those capital markets are excellent from a safety and security perspective. Importantly, the rule of law applies, and they fit a little informal criteria that we use within Riverside. We like to see two free, unfettered elections out of a country before we invest there.

It's a bit glib, but it's a good proxy for what we're trying to get at, which is we don't want to take political risk. We have to be absolutely confident that five to seven years from now there will be a good market that will fully value the types of companies we own.

Q: Much of your success comes from the people you hire. Who is the ideal Riverside job applicant?

A: The common thing you would find around the world with Riversiders -- in addition to being consummate professionals -- is that they are people of character and value. The key is hiring folks who innately want to do business that way.

We have a written set of business principles, and if I overly simplify them, they really just say two things. One is live by the Golden Rule, and the other is leave great references in your wake.

The golden rule is basically doing what our mothers told us to do when we grew up. Not every private equity firm behaves that way. If we just wanted to do a deal or two a year, we could pillage, too. When you want to do 28 or more deals a year, you're going to quickly be known by how you treat people.

Leaving great references in our wake really didn't start as a business development scheme. It started because it just felt like a nice way to do business. When you treat people fairly and live by your word, people want to do business with you again and again.

This "On The Record" interview was conducted by Business Editor Paul O'Donnell and reporter Alison Grant.

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